To Escrow or Not to Escrow...That is the Question

To Escrow or NOT to Escrow....That is the Question

First, let's define an escrow account. On a mortgage loan, an escrow account is basically a savings account that you pay money into each month so that the mortgage lender can pay your homeowner's insurance and real estate property taxes when due. You might think of your monthly mortgage loan payment as a lump sum due on the first of the month, but if you have an escrow account that amount is included in how much you pay.

Why HAVE an escrow account. There are 5 reasons:

1. It's required by your lender
2. On many mortgage loan programs, if you are putting less than 10% down-payment towards buying your home, your mortgage lender will require you have an escrow account.
3. It gives you peace of mind **Note**  For clients that are not required to have an escrow account, this reason is the most often given for wanting to have one. At its core, it is the fear of having too little discipline to set aside the money yourself and be responsible for it.
4. If you aren't disciplined, you could lose your home to tax foreclosure
5. If you have an escrow account and pay your mortgage + escrow payment each month to your lender, you won't have to worry about past due taxes. If you decide to manage your taxes and insurance on your own, failure to pay your taxes has dire consequences. You MUST have discipline to do this yourself.

Why NOT have an escrow account. There may be more but I can think of 4 (rhyming unintentional):

1. LESS money due from you at closing.  When you close on your mortgage loan with an escrow account, the initial setup of an escrow account requires a "cushion" be collected. Think of it as extra money paid up front to make sure there is enough in your escrow account if your taxes or insurance costs increase in the future. Because money doesn't grow on trees (at least not in my yard) I'm against anything that reduces your cash reserves just to protect the mortgage lender against future increases. I believe you are in a better position with 3 months mortgage payments saved in your bank account after closing on the home,  then with that money held by your lender "just in case" your taxes or homeowner's insurance goes up.
2. Greater risk of having a late mortgage payment and damaging your credit history.  If your borrow $100,000 at 6% your monthly principal and interest payment on a 30 year loan is $600/month. If you live in Collin County your annual taxes are approximately $2,850 ($237/mo) and annual home owners insurance would be $775 (65/mo).  What this means is that your monthly MORTGAGE payment is $600 per month but your monthly MORTGAGE + ESCROW payment is $902 per month. If you only have $700 one month to pay because you got sick or hurt or lost your job or _______ (fill in the blank) then you can make your mortgage payment and prevent risk of damaging your credit or worse. If you have an escrow account, then even though you can pay the amount needed to keep your mortgage on time, you will still be considered late. By having an escrow account you are agreeing to a higher monthly payment above and beyond the mortgage.
3. You can earn interest on your own money you are saving to pay taxes and insurance. If instead of paying $902 per month in the scenario above, you paid the $600 each month to the lender and saved the $302 in a savings account you would at least be able to keep any interest you earn. The mortgage company is doing this with your escrow money and keeping the interest.
4. Greater chance of earning early payment discounts from your insurance company or taxing authority.  In some counties you can get a discount for paying your property taxes in December. They are considered past due until the end of January. If you have an escrow account, rest assured your lender is paying the taxes at the last possible date. If you control escrows, you could take advantage of early payment savings in some cases. Check with your county tax assessor to see if this applies to your home.

I am a strong advocate for people to understand they have a choice in the decision about having an escrow account. It does require discipline to do it yourself, but no more discipline than making your monthly car or mortgage payment. The only difference is you pay yourself. Setup a second savings account at your bank and have the money automatically transferred from checking to savings once per month.

Make a decision that is right for you but understand the risks and rewards of each option.

©2006 Ken Stampe

Ken Stampe is a Mortgage Loan Originator, Mortgage Author and Mortgage Loan Officer Instructor living in Dallas, TX. Ken provided his first client a mortgage loan in 1996 and writes about home buying and mortgages to help clients make smart home mortgage loan decisions. Contact by email Ken@MortgageLoanDallas.com

What resource do SMART home buyers use?... Mortgage Calculator Bank.com